NPA resolution: One size doesn't fit all

A sector-wise approach and an enabling legal and regulatory framework are needed to make the most of the NCLT mechanism

The sizeable and growing problem of non-performing assets in the banking books is a national concern. Policy makers, banking regulators and the banking system have been making concentrated efforts to resolve the NPA issue. Their efforts have begun to show first signs of results. It is debatable whether demonetisation pushed back the resolution by four to five quarters as the banking system was seriously engaged with changing notes after November 2016 for two quarters and then the GST reform happened.
 
Be that as it may, the most commendable reform on insolvency and bankruptcy law will ensure a long- term constructive impact on the financial lending system in the country. The new breed of resolution professionals working closely with the borrowers, lenders and the judicial system would ensure a lasting impact on financial lending in the country. Like in every field, here too we will have efficient resolution professionals on the one hand and ineffective ones on the other. Laws will evolve to weed out the non-performers. We will need a competent legal and regulation framework to evaluate this profession in the years to come.
 
We should now create a sound approach to study the resolution so far and conduct an independent and dispassionate assessment of the factors that contribute to those cases where the haircuts are minimum or where there is a healthy order of interest among investing corporates to acquire capacity. Factors may be external to the resolution and the buying corporates. This will include economic outlook, sectoral performance of industries, capacity utilisation in different sectors and therefore the earning potential. They may be inherent to a specific case where there was over-leveraging by the promoters and of course there will be cases where there have been misappropriation of lenders’ funds.
 

Working in Concert: Policy makers, banking regulators and the banking system have been making concentrated efforts to resolve the NPA issue. Their efforts have begun to show results

From the progress made so far, and it’s too early to draw conclusions but the most obvious observation is that sectors where the outlook and the potential is promising, resolution will happen. Both the promoters and the banking system may find comfort in the outcome.
 
This however brings an important hurdle that the banking system and other financial lenders, participating in the Committee of Creditors (CPC) process, may face. The obstacle is in the legal and regulatory framework which does not envisage a sector-wise approach. If the promoters are not allowed to participate in the acquisition of assets, directly or indirectly, then it could become an obstacle. This is the problem with hard coding the process. It may pose larger problems as we approach mid- and small-sized enterprises. Those associated with sectors that are recovering and have potential like steel, perhaps, are certainly resolvable. Others, that account for a sizeable pie of the NPAs, will need different approaches and a substantial amount of flexibility.

In this context let us look at the composition of NPAs across sectors. The three large sectors that need to be evaluated because of their size are energy, telecom and steel. The three sectors have vastly different inherent issues to be resolved. The energy sector, particularly the power distribution companies, is the most tricky one. None of the present reforms are capable of addressing the core issues. These arise largely due to the policy makers—both the states and the union have to evolve methods of freeing the banking system from this asset item. Within the energy sector, coal and renewable energy need to be resolved very differently and policy makers, rather than resolution professionals or the NCLT process, might be able to address these NPAs.
 
The telecom sector, thanks to the policy reversals and spectrum auctioning price mechanism, spiced by the earlier CAG report findings, has been a major headache for the banking sector. In both these sectors, there are no visible resolution approaches and the size of haircuts can only grow with the passage of time. The recapitalisation of the banks also may not work. Banking intermediation may grow, and the loan book may become bigger, but the absolute NPAs will not go away. There can be no mention of the agriculture sector in the present resolution and so long as the state governments pay for loan waivers, the banking system is protected. Only the steel sector looks a bit promising. Nothing perhaps to do with resolution or the NCLT mechanism, except that effective resolution could become faster, if handled with care.
 
For the mechanism to work effectively, policy makers, the regulator, the resolution professionals and the lenders must evaluate a new framework which would provide the required flexibility for asset resolution. A new structure, organisations and skills will be required to ensure decision making and sectoral flexibility. Resolution professionals with substantial sectorial expertise would help. As the economic outlook brightens, let us have enabling provision in the legal and regulatory framework to make the most of it.  The author is managing partner, Ashvin Parekh Advisory Services LLP